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Why the New PMI Reduction Will Reel in FHA Borrowers

money-houseThe recent reduction in private mortgage insurance fees has made getting a mortgage loan a lot easier and may begin to pull high quality borrowers from the Federal Housing Administration (FHA).

Urban Institute researchers Bing Bai and Laurie Goodman found in a recent report that borrowers that can afford a monthly mortgage but do not have the 20 percent down payment, have two options: 1. A FHA loan or 2. A conventional mortgage guaranteed by the GSEs. While both programs allow borrowers to put as little as 3.5 percent down, one may be better than the other.

"For the past 15 months, the answer has been the FHA loan," the authors wrote. "But for those with nearly perfect credit, a change to PMI fees in April 2016 made the GSE guarantee more affordable. This new pricing could pull some of the highest-quality borrowers out of FHA and into GSE loans."

FHA offered a more affordable monthly payment than a conventional loanUrban Institute reported that under the old PMI pricing, FHA loans were the better deal. When this price cut occurred, private mortgage insurers were faced with tough competition.

The White House in January 2015 that the FHA will reduce mortgage insurance premiums in an effort to boost U.S. homeownership. FHA cut its mortgage insurance premiums to 0.85 percent, a 0.5 percentage point reduction.

In 2015, PMIs lost market share to FHA, Urban Institute found.

Low FHA premiums drove market share to 40 percent of all mortgage insurance in 2015, up from 34 percent the previous year. Meanwhile, PMI’s share declined from 40 percent to 35 percent in the same period. From 2010 to 2014, PMIs were picking up most of the market share as FHA premiums rose several times prior to the cut.

The report determined that the better deal depends on the credit score of the borrower.

FHA offered a more affordable monthly payment than a conventional loan"For borrowers on the lower end of the credit spectrum, the higher PMI rates make conventional loans even less attractive than before," the authors noted. "This preference could add to FHA’s adverse selection, in which  borrowers with lower FICO scores disproportionately gravitate to FHA financing over conventional loans with PMI."

The authors continued, "The new private mortgage insurance pricing will likely increase the GSE share of low down–payment, high-credit borrowers. The overwhelming majority of FHA borrowers make down payments between 3.5 and 5 percent. Of these, 32 percent have FICO scores above 700—the range where the PMI premium is decreasing. Nearly 12 percent have FICO scores above 740 and may now find GSE execution to be more attractive. While the number of borrowers who will now choose the GSE mortgage over the FHA mortgage remains to be seen, we would expect it to be small but noticeable."

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